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What is Environmental Investment?


Many people confuse ethical investment, sustainability investment and environmental investment. These are the three main types of environmental investment that have arisen over the past 30 years, and while each has a contribution to make to the environment, they also have key differences as investment strategies.

Ethical investment was the first approach to develop; it has some history in the 19th century and began more formally in the 1970s and 1980s. Ethical investment is based on a process called negative screening - filtering out those investments that are seen to be harmful and therefore not consistent with an investor's or fund manager's values. The most common activities screened out are tobacco, alcohol, armaments, human rights abuses, animal cruelty, and pollution, among others.

Ethical and sustainability funds may invest in a property trust because it is energy efficient, but the electricity flowing to the properties owned by the trust may still come from a coal fired powered station

The second form of environmental investment to emerge was environmentally positive investment. This is based on identifying activities that are beneficial to the environment. The sector began to gather pace in the early 1990s and the Environmental Investment Directory of Australia, which I authored in 1992, was I believe the first public listing of environmentally positive investments in Australia. A few years later the term "positive screening" began to gain currency and more recently the terms 'clean technology" or "cleantech", and "clean energy" have also emerged to describe major sub-sets of environmentally positive investment.

Sustainability investment was the most recent to emerge, in the 1990s and early 2000s, and has developed with the growing use of sustainability reporting. Sustainability investment is also known as "best of breed" investing. It is based on identifying those businesses that are the most sustainable in their industry based on sustainability criteria such as business principles, utilization of resources, treatment of staff, approach to customers and suppliers, governance issues, contribution to the community, and others. These are sometimes summarized as "ESG" - environmental, social and governance factors; and "CSR" - corporate social responsibility.

All three strategies make a contribution to the environment, and can be employed successfully as investment methodologies. Ethical investment screens out investments that harm the environment, sustainability investment identifies businesses that make the most efficient use of their resources as part of a long-term perspective on the environment, and environmental investment identifies those investments that have a positive effect on the environment.

However, the public often confuses these strategies for two reasons. The first is that the demarcation between them is not always clear and some crossover is normal. So some ethical and sustainability strategies may also utilize positive environmental screening to varying degrees. However, the commitment to environmental issues varies considerably between fund managers. Some ethical fund managers only employ negative environmental screens, while the more committed also use positive screening. Likewise, some sustainability fund managers seek the best of breed businesses across every industry sector, while the more environmentally committed will use negative screening to filter out unsustainable industries and activities and positive screening because environmental technologies are often required to achieve resource efficiency.
The second reason for public confusion is a degree of "greenwash' in the marketing of the ethical and sustainability sectors and some of their financial products. The environment is often the part of ethical and sustainability investment the public is most interested in. So fund managers may emphasize this aspect of their industry and funds in their marketing, giving environmentally positive investments a higher profile than they actually have in the funds themselves. When investors think they are getting a positively screened environmental investment, fund managers can be disinclined to disabuse them or to explain the differences between the three strategies.

The key difference between environmental investment and ethical and sustainability investment is that environmental investment is focused solely on environmental issues, whereas both ethical and sustainability investment incorporate a much wider range of issues of which the environment is only one. At a portfolio construction and stock selection level, ethical and sustainability investors have a far larger universe of stocks to choose from, many of which are unrelated to the environment. In a typical ethical or sustainability portfolio, the environmentally positive component is a minority and more often a small minority of the assets.

In essence, sustainability and to a lesser extent ethical investing are diversified investment strategies. Sustainability funds are likely to have holdings across all major industry sectors, with only the most committed managers negatively screening for harmful activities and positively screening for environmentally positive activities. Some also invest in companies that may be environmentally controversial or harmful.
Ethical investors will also hold many mainstream investments across most if not all major industry sectors. A typical portfolio includes banks, insurance companies, property trusts, manufacturers, infrastructure, etc, and some managers may also positively screen for healthcare, education, housing, the environment and other socially beneficial activities.

In contrast, environmental investors have a much smaller universe of stocks to choose from. Environmental investment is theme investing - like many other themes on the stock market such as resources, gold mining, healthcare, pharmaceuticals, information technology, infrastructure, media etc.

However unlike some of these other themes, environmental investment is not as easy to define. In a broad sense, environmental investment does include ethical and sustainability investment, but because this can lead to confusion there is a need for a more specific definition solely for environmentally positive investment.

Because the focus is on business activities that are environmentally positive and address environmental problems and issues, the definition formulated and used by Eco Investor Magazine is "Investments that solve environmental problems".
This "problems and solutions" approach to defining environmental investment is identical to that used in many other investment sectors. For example in the pharmaceuticals sector each pharmaceutical addresses a specific disease, condition or health issue.

There are a large number of environmental problems around the world. Among the well known are global warming, pollution, waste management, native forest destruction, habitat destruction, species extinction, feral animals, weeds, land salinity, declining wild fish stocks, water availability, and water quality. Many other problems are less well known or are specific to certain parts of the world or circumstances.
Not all environmental problems have immediate solutions, some at present have only partial solutions, and even where there are solutions these can still require time or further development to resolve the problem.

Examples of clearly defined environmental problems and full or partial solutions include:

  • Environmental Problem - Solution
  • Global warming - Renewable energy, low carbon fuels
  • Native forest destruction - Plantation timber
  • Waste and landfill availability - Recycling
  • Habitat damage - Eco tourism, environmental engineering, site rehabilitation
  • Declining wild fish stocks - Aquaculture, mariculture
  • Chemicals in food/ ecosystem - Organic agriculture
  • Vehicle pollution - Improved technology, public transport, rail, electric vehicles, bicycles

Environmental investment is about the business activity of devising, commercializing and selling environmental solutions for commercial gain.
While many ethical funds and sustainability funds make a useful contribution to the environmental, by themselves they are not sufficient to solve environmental problems. For example - ethical and sustainability funds may invest in a property trust because it is energy efficient, but the electricity flowing to the properties owned by the trust may still come from a coal fired powered station, adding to the problem of global warming.
An environmental fund using the "problem and solution' approach would look for a power station that is powered by renewable or low carbon fuels, or that has a new technology to improve coal efficiency.

Another way to highlight the differences between the three strategies is to draw an analogy with human health. Ethical investment and negative screening are similar to a person avoiding those things in life that damage their health - tobacco, drugs, gambling, violence, reckless behavior, too many late nights, etc. Sustainability investment is similar to a person doing all the right things to stay fit and healthy - plenty of sleep, good diet, regular exercise, social involvement, etc. Environmental investment is similar to what happens when the person gets sick - they go to the doctor for a diagnosis and a remedy or pharmaceutical for that condition. Thus environmental investment is a form of diagnostic environmentalism or medicinal environmentalism.

So all three investment strategies - ethical investment, sustainability investment, and environmental investment, help the environment. Most ethical and sustainability investment can be classified, in the positive sense, as light or medium green. Environmental investment, because it focuses on environmental problems and addresses their causes, is at the deep green end of the environmental spectrum.

Victor Bivell is editor of Eco Investor Magazine, for more informative articles on Investing visit his website

This article was featured in The Australian Newspaper and also in The Eco Investor (June 2008)

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    Betsey says:

    Way to go on this essay, helepd a ton.

    8th November 2011 . 12 years ago